As all good news junkies at Naked Capitalism no doubt have figured out, Mr. Market had a bad day yesterday, and still seems not too happy overnight. The Dow dropped 4.6%, or 1,175 points, bouncing back from a decline of over 1,600 points. All major US and foreign stock indices are down for the year. Today’s fall puts the Dow down 8.5% from its peak in January. The drop in the S&P 500 and the NASDAQ were slightly less dramatic, at 4.1% and 3.8% respectively. The VIX more than doubled. The CBOE Volatility Index rose by 124% at its intraday peak, and closed up nearly 116%, at 37.82.

WTI fell 2% to $64.15, and Treasury bond prices rose, as the yield on the 10-year fell from 2.852% to 2.794%.

And in the background, Bitcoin fell by 20% to below $7,000 and closed barely above that level at the end of the day. From Bloomberg:

Bitcoin tumbled for a fifth day, dropping below $7,000 for the first time since November and leading other digital tokens lower, as a backlash by banks and government regulators against the speculative frenzy that drove cryptocurrencies to dizzying heights last year picks up steam…

Weeks of negative news and commercial setbacks have buffeted digital tokens. Lloyds Banking Group Plc joined a growing number of big credit-card issuers have said they’re halting purchases of cryptocurrencies on their cards, including JPMorgan Chase & Co. and Bank of America Corp. Several cited risk aversion and a desire to protect their customers.

Overnight, as of this hour (3:30 AM) the Nikkei closed down 4.7% and the FTSE is nearly 3% lower. The Dow and S&P 500 futures had been down when I kept checking (the NASDAQ would occasionally rise into positive territory) and as of now, Dow futures are down 119 while the S&P is up 6 points and NASDAQ futures, up 36 points.

The US stock market selling was largely algo-driven as the market dropped through technically important levels, triggering more selling. Bloomberg says traders weren’t panicked while a Wall Street Journal headline blared the reverse, so you can decide which version of yesterday you like better.

The bigger question is what if anything this means. The simplest version is the markets had gotten way too frothy (even sober types like Mohamed El-Erain had been pretty alarmed for months) and the nature of lots of algo in the market means that downturns are more likely to be violent than in the past.

But another way to read it is that this particular downdraft is a symptom of how much owners of securities think that what is good for workers is bad for them. This is a reversal of the old post-war economic model, in which policy-makers focused above all on rising wage rates as the driver of prosperity. That went out the window with the 1970s inflation. The Fed, starting with Volcker, has made curbing inflation a bigger target than fostering growth, and has become more and more eager to create more unemployment in order to curb wage growth, which they see as the driver of inflation. That is a pretty dated view of the economy, since in the 1970s, not only did labor have more bargaining power, but many companies had formal or informal policies to increase wages in response to inflation, which had the potential to create accelerating inflation. Not only does that practice no longer exist outside the executive suite, where pay consultants seem expert at creating excuses to increase CEO pay vastly faster than inflation or performance would warrant, but much of what looks like inflation occurs in selected sectors (health care, broadband prices, higher education) as a result of aggressive use of pricing power.

More specifically, the most common explanation for the market swoon is that jobs reports on Friday that showed what were interpreted as strong wage gains would lead the Fed to decide it was behind the curve and at least stick to its three planned rate increases this year, and potentially make them a bit sooner than expected. And these rate increases come with a backdrop of adequate to pretty good (by “new normal”) standards around the world, so no other major central bank is expected to be easing this year and therefore provide something of a buffer to the Fed’s tightening.

However, over at Bonddad, New Deal democrat parses the data and takes issue with the conventional reading of the Friday jobs report. His take is that most workers didn’t get much in the way of pay increases, that the gains were mainly in the supervisory classes. From his post:

I wanted to follow up on why I dissented Friday from the near-consensus take that workers finally got a nice raise, with many citing hikes in the minimum wage. As you may recall, the YoY% change in the average hourly earnings of all employees rose 2.9% as of January.

Average hourly wages jumped 9 cents, or 0.3%, to $26.74, according to the Bureau of Labor Statistics. That means wages have increased 2.9% over the last year — the biggest gain since the end of the Great Recession in June 2009.The federal minimum wage is $7.25 an hour and hasn’t increased since 2009. But many states and municipalities enacted laws to raise the wage this year….

The reason I dissented is that the YoY% increase for nonsupervisory workers was only 2.4% — right in the range it has been for over a year. As Jared Bernstein, who called the number “A Nice Wage Pop,” pointed out:

There were some weak spots in the report. Wage growth for the lower-paid 80% of the workforce that have production or non-managerial jobs was up only 2.4%, implying that faster wage growth last month mostly benefited higher-paid workers.

Both types of workers are literally from the same survey — i.e., the one measure is a subset of participants in the whole survey. So if minimum wage hikes were responsible for the big YoY increase, we should see it in their hourly wages.

In January’s case, we don’t.

Since nonsupervisory workers account for about 80% of all workers (h/t Bill McBride), we can back them out of the total figure, and calculate the YoY% increase in wages for managers…

While regular workers saw nominal wages go up a little under 0.2% per hour, their bosses saw wages go up 0.8% per hour!

So this is pretty rich. The Fed and the investor classes are getting worried that the labor markets might be getting too tight, as shown in the wage data…when properly disaggregated, it shows instead that what is going on is ho-hum increases for the masses, and more transfers from them to the managerial classes.

Now in terms of the bigger picture, so far, even though the stock market has looked very much ahead of itself, and could well have some more air taken out of it before it settles down (and that could be an intermittently very bumpy ride that takes some time to play out), there aren’t any signs of blowback to credit markets or lending institutions. Even very big stock market busts with no meaningful debt market involvement, like the dot-bomb era, have only limited real economy impact.

Having said that, there are some possible worries on the horizon. One is China. People have been wondering for so long about how long China can keep its debt-fuelled growth going that the worry-warts look a lot like the boy who cried “wolf”. And even though China’s visible metrics do appear to be improving, no one has a good handle on what experts have come to see as its real risk, its “shadow banking system”. Another view of China’s risk came from Steve Keen, who was one of the few economists to call the 2008 crisis, was that a mere slowing in China’s debt growth would be enough to precipitate big time trouble. But with data out of China being fabulously unreliable, who knows if and when things will crack.

Another wild card is Brexit, but the inertial path there is to kick the can down the road till December 31, 2020, although if the UK sticks to its guns and really does leave the single market, it’s going to suffer major dislocations. I should write it up, but we now have the unhinged behavior of the Tories managing to reach new levels, as pretty much everyone seems to be trying to blame Theresa May for a mess that has resulted from a divided party and utter delusion about what anyone could obtain. Even though ultras are threatening the horror of putting functional morons like Rees-Mogg in positions of authority, she appears able to take a phenomenal amount of pounding and does not appear inclined to leave unless forced. Despite all the caterwauling, it’s hard to imagine that the Tories would go the “no confidence” vote route, particularly since the last two times it was used successfully was in 1979 and 1924.

However, the internal contradictions of the hard Brexiter positions are becoming more and more impossible to maintain, and wore, the ultras seem delighted with the prospect of blowing things up if that’s what it takes to get what they want. This means the risk of a “hard Brexit” or even worse, an apocalyptic “no deal” departure in March 2019 are real. That would be a very very ugly ride, as well as terrible for the citizens of the UK.

But as the discussion above suggests, the real danger is that the neoliberal model is increasingly under stress, as the consequences of rising inequality and unheard-of low levels of the benefits of growth going to laborers undermines the legitimacy of the system and is producing bad outcomes ranging from political fracture to falling life expectancy and an opioid crisis that is in large measure the result of the collapse of typically rural communities. The last thing the US needed was more transfers to the rich in the form of the Trump tax bill. So while Mr. Market may recover his sunny mood, the foundations of the economy continue to rot.

Update 7:20 AM: Mr. Market is in a less cheery mood that he was at 3:30 AM. Dow futures are now down 378 points, the S&P mini is down 28.50, and the NASDAQ mini is down nearly 47 points.

From September, but the last 1/3 of the article talks about a what-if scenario that seems to be happening now

Interestingly the article predicts a flat VIX term structure in advance of the short vol trade blowing up, as that takes away the easy money from the trade, and verily last week the VIX curve from what I saw on the interwebs, was flat

The bottom line is that the Big (Volatility) Short is an excellent trade that takes advantage of an upward sloping term structure in the $VIX futures. If that term structure, however, flattens or begins to slope downward, bad things happen to the Big (Volatility) Short trade. The rapidity with which the term structure makes that change will have a lot to do with just how bad the losses are that are incurred by the volatility shorts. Most smart players – hedge funds, family offices, etc. – are quite leery of the short volatility trading strategy right now, because of the extremely low levels of $VIX and because it’s such a crowded trade. However, it seems that “everyone” is warning against the trade right now, so it will probably continue to work for quite some time before – unexpectedly – a problem explodes on the scene.

So a doubling in one trading session – yesterday – of a VIX which has been long-term depressed by the same monetary policies which blew the MoAB, Bubble 3.0, would seem to have qualified as ‘unexpectedly’. And ‘some time’ in this case turned out to be a mere 5 months, pretty damn good in “the market can stay irrational longer…” terms.

Thanks for that. Never heard that quote before and had been wondering about what seemed to me at best a dubious assumption.

I’ve pointed out in the past that I have some inventory of ossified cat turds in my basement and while theoretically according to some economist there is a market somewhere for them, there probably shouldn’t be.

Good coverage Yves. I think you covered all the major strands of explanation. My open question is this: will the strains of falling markets reveal structural fault lines in the shadow banking system that have not been apparent? So far, no, but we are in the early downhill phase.

XIV is one of the ETFs I’ve been keeping an eye on (but no money in, thankfully) during the current swoon – down 20% yesterday, checked today, that was a ‘wtf?’ moment, for sure. Gonna be a huge shock to all those complacent buy-and-holders for whom this ‘never fight the Fed’ ETF had become a seeming neverending gravy train of gains from betting on volatility getting crushed ever closer to 0.

And I see the marketeers have rallied their panicked troops and are attempting a counercharge … would love to have a live macro ‘battlespace map’ of the money flows involved in the last few days.

Its pretty clear the main driver is meltdown in the “volatility complex”. Through the layers and layers of crazy products and hedges eventually the underlying market takes a hit. Not to discount long term fundamental issues and imbalances but I think right now its a flash crash type technical problem confined to equity that gets papered over quickly. Reminds me of portfolio insurance back in the 87 crash. Wow am I old.

How long until asset price correlations start to move higher? Will the preponderance of ETFs now have any effect on how quickly correlations move toward 1 as they did in 2008 due to margin and collateral calls?

Wage inflation,yes, but they’re really worried about the rising cost of corporate debt if the Fed hikes even faster due to wage inflation. If the interest on Corp debt isn’t better than that on safer US debt then the market for especially junk bonds will evaporate leading to bankruptcies. Wolff Richter has written about this, and how they misused their QE magic money tree.

This is also why they needed Corp tax cut ASAP, to stave off the inevitable stock market rout, although they should know better.

– The Fed will continue to raise its target range for the federal funds rate.

– The 10-year yield will follow.

– As the Treasury yield curve, which is still relatively flat, steepens back to some sort of normal-ish slope, the 10-year yield will make up for lost time over the past year and will rise faster than the Fed’s target range for the federal funds rate.

– Corporate bonds will follow, but they have even more catching up to do, and so they will rise even faster than the 10-year yield, as yield spreads between the 10-year Treasury and corporate bonds widen back to some sort of normal-ish range.

In other words, corporate yields will rise further and faster than Treasury yields, just to catch up, thus pushing down prices with gusto. Junk bonds are more volatile and will react more strongly. Junk-rated companies will find it more difficult to raise new money to service their existing debts and fund their money-losing operations, and there will be more defaults, which will push yields even higher as the risks of junk bonds suddenly become apparent for all to see. This will make it even tougher for companies to raise funds needed to service their existing debts and fund their operations.

I agree with the overall thesis of what’s driving the market swoon at the moment. But I disagree when Wolf says the 10Y yield will follow the Fed Funds rate. E.g. see this graph: https://fred.stlouisfed.org/graph/?g=i9XE. If you stretch it back far enough, the 10Y yield and the Fed’s fund rate are pretty independent of each other.

About the only relationship they have to each other is when they get inverted, that that precipitates a recession. E.g. see when the Fed Reserve did that in May 2000 and June 2006 in that same graph. That’s when the punch bowl is gone, it just seems to take a while for that to work its way through the system.

I seem to recall that Wolf had a previous posting where he argued that the 10Y yield was going up because of other factors: the tax cuts, Fed Reserve unwinding its balance sheet, etc. So basically the same effect. Everyone is scared the bond vigilantes will finally have sway. To your point, corporate bonds will get more expensive to roll. And to your point, tax cuts will help them finance that. What it certainly means though is the good old days of stock buy backs would be over. Oh the humanity, lol.

One question I have is whether the corporations would actually retire the debt instead of roll it over; retiring the debt should be deflationary. But I suspect most corporations don’t have enough cash flow to actually retire debt, even with the tax cuts. As usual, Banks to US: “all your cash flow are belong to us”.

By the way, a counter thesis is that the bond vigilantes won’t have sway and the 10Y yield will revert to the path it’s been on since 1982. In which case, the market is saved, yay! But then it would still be on path to an inverted yield curve anyways, boo! I guess time will tell.

By the way, the 13 week treasury yield (which the Fed Funds rate tracks) is at 1.49%. Only 3 to 6 more basis points and the Fed Reserve will be due to increase their Fed Funds rate another 25 basis points. Imagine the optics of that happening during this market swoon or soon after. Heads are going to implode, particularly Trump’s. But to my point above, corporate debt is not exposed to that.

It separately still begs the question on whether the 13 week treasury actually anticipates the Fed Funds rate. Or if the Fed Reserve is actually forced to follow the 13 week treasury. One way to get more clarity would be if the Fed Reserve actually sat on increasing their rate, e.g. just to avoid spooking the markets more. It will be interesting to see how this plays out.

“…much of what looks like inflation occurs in selected sectors (health care, broadband prices, higher education) as a result of aggressive use of pricing power.”

I would argue all three inflated sectors have different origins. Escalating healthcare costs are largely due to the perverted incentives for healthcare cost control. When there is no real incentives for patients (through utilization) or insurance companies to control costs (they themelves would actually make less money if they significantly controlled costs) but rather to pass on the costs through higher premiums, you get the year over year increases there.

Escalating cable/broadband prices are most likely due to monopolies or duopolies in service areas which allow for pricing power.

Out of control tuition costs in higher education are a combination of student loans, acting as the fuel, to allow for students to be less price sensitive to rising tuition which goes to pay for everything but education such as excess administrative costs, fancy dining and athletic/gym facilities, etc.

Two;

People have been wondering for so long about how long China can keep its debt-fuelled growth going that the worry-warts look a lot like the boy who cried “wolf”.

I wonder if there is a parallel with what happened in the US were deregulation in lending (credit card and mortgage) in the late sixties and early seventies (after we fully went off the gold standard) created the greatest debt bubble known. That took about 40 years to finally pop with the Global Financial Crisis.

Appreciated your final sentence and paragraph in this post before the Update, as well as your observations on the Fed’s obsession with suppressing wage growth beginning with Volcker, which you have mentioned before. But I expect the QE-ZIRP Welfare Queens will soon enough have their way with their former capo and new Fed Chair, if they haven’t already. They will make every effort to restore order and keep market prices elevated. Gotta have those stock buybacks that make CEO stock options so lucrative and have fueled political contributions by the One Percent under their Orwellian-named Citizens United decision. Too bad this has been so mismanaged and gotten so frothy. As usual, I expect the wrong people will get hurt.

As an additional piece of news. Beijing did just announce an end to bitcoin in the PRC. They had previously chosen to block domestic exchanges and as of this week they plan to block access to all foreign exchanges as well. While that is not a direct assault on the shadow banking system it will tighten one mechanism by which those banks route their money out of the country or otherwise conceal it. Whether that counts as a serious cleanup or just eliminating competition is another matter. Either way it isn’t good for the price of a BTC.

The FRED weekly earnings data don’t show even the raise that the hourly data purport to show. Average weekly hours down, more than enough to wipe out the small rise in hourly wages. Hourly wage growth for production workers is actually near a low point for the post-2009 expansion.

This wailing about wage inflation looks like certain policymakers and media types deliberately amplifying statistical noise to serve their own agendas.

the real danger is that the neoliberal model is increasingly under stress, as the consequences of rising inequality and unheard-of low levels of the benefits of growth going to laborers undermines the legitimacy of the system and is producing bad outcomes ranging from political fracture to falling life expectancy and an opioid crisis that is in large measure the result of the collapse of typically rural communities. The last thing the US needed was more transfers to the rich in the form of the Trump tax bill. So while Mr. Market may recover his sunny mood, the foundations of the economy continue to rot.

For news in the same vein, this soon to be published book should be quite interesting…

Sure, I’ll have a go. Logical doesn’t necessarily mean maximal. The lines intersect at a nonzero point. If they took wages to zero, who would cook and clean and mow and so on for them? They’re damn near helpless without us.

Pretty revealing curves, too. How much human can we be at a given wage level? Starvation level, subsistence level, on up through housing wage to, dare I dream? Living wage.

Pity the poor PTB, terrified that we might get up from our knees.

ISTM us “modern” workers work way more than our Stone Age ancestors likely did. I doubt they had only 2 days off a month, like I do. It’s my understanding that, in “primitive” cultures, people spent most of their time being people. And still spend, since they’re not all dead yet.

If work we must, I wish everyone had a livelihood, not just a job. The difference is, the more you give a livelihood, the more it gives you back.

And my understanding is that as long as food was relatively plentiful, “Primitive” cultures actually had a fair amount of free time on their hands as one’s daily nutritional needs could be met with a few hours of effort.

No wonder so many Westeners went “Native” at times. Whether it was living with Native American’s or British sailors in the South Pacific. Frankly hanging out on the beach in Tahiti seems preferable to me.

And most natives who were not turned into slaves reverted back to thier roots when they got home. Fitzroy, of the Beagle and Darwin had brought some of the residents of Tierra del Fuego home to England with him. When returned they tried to teach them to farm, but upon their return, years later. The natives had abandoned the hard work of farming to become hunter gatherers again. When found one of them replied, “why do that when there is Plenty Fishies, Plenty Birdies?, etc” -Probably not an exact quote, but along those lines.

As to zero wages, that would be slavery, the base of one of those curves perhaps, but today’s base is better, because their is no responsibility that comes with being a slave owner, or a feudal lord I suppose. People can be left to die, preferably quietly.

>> So this is pretty rich. The Fed and the investor classes are getting worried that the labor markets might be getting too tight

Didn’t Marx say that after a boom the rate of profits starts to fall and capitalism experiences a contraction (apology to Marx for the very rough paraphrase but I think that was the gist)? Labor costs eat into profits. The party of record profitability and record share prices is threatened by the first clouds on the labor horizon… so there. Mr Market is very finely attuned to any whiff or rising labor costs.. Marx explained it all, what – 170 years ago…